Pivot point resistance is a concept in stock technical analysis that uses pivot points to identify potential resistance levels. Pivot points are calculated using the high, low, and closing prices from the previous trading period, and they provide a framework for predicting future price movements. Here’s a detailed explanation of pivot point resistance and its application in stock trading:

What are Pivot Points?

Pivot points are a set of calculated levels that traders use to determine potential support and resistance levels for the upcoming trading session. The primary pivot point (P) is the central level, and from it, several support and resistance levels are derived.

Calculating Pivot Points

The pivot point (P) and its corresponding support (S) and resistance (R) levels are calculated as follows:

1. Pivot Point (P):

   P=(High+Low+Close)3P = \frac{(High + Low + Close)}{3}P=3(High+Low+Close)​

2. First Level of Resistance (R1):

   $$R1=2P-Low$$

3. First Level of Support (S1):

   $$S1=2P-High$$

4. Second Level of Resistance (R2):

   $$R2=P+(High-Low)$$

5. Second Level of Support (S2):

   $$S2=P-(High-Low)$$

6. Third Level of Resistance (R3) (optional):

   $$R3=High+2(P-Low)$$

7. Third Level of Support (S3) (optional):

   $$S3=Low-2(High-P)$$

How Pivot Point Resistance Works

1. Central Pivot Point (P): This is the average of the high, low, and close prices from the previous period. It acts as a reference point for the day.

2. Resistance Levels (R1, R2, R3): These levels are calculated above the pivot point and act as potential resistance levels. Traders watch these levels to anticipate where the price might encounter selling pressure.

Practical Application

1. Identifying Resistance Levels: Traders use R1, R2, and R3 as potential resistance points where the price may reverse or encounter difficulty moving higher.

2. Trading Strategy:

   • Sell Orders: Traders might place sell orders around these resistance levels, expecting the price to struggle to move above them.
   • Stop-Loss Placement: Traders may set stop-loss orders just above these resistance levels to manage risk in case of a breakout.
   • Breakout Confirmation: If the price breaks through a pivot point resistance level with significant volume, it may indicate a strong bullish trend, and traders might enter long positions.

3. Day Trading: Pivot points are particularly popular among day traders, who use them to make quick trading decisions based on the anticipated support and resistance levels for the day.

Example Scenario

Suppose a stock had the following high, low, and close prices on the previous trading day:

• High: $120
• Low: $110
• Close: $115

The pivot point and resistance levels would be calculated as follows:

• Pivot Point (P): P=(120+110+115)3=115P = \frac{(120 + 110 + 115)}{3} = 115P=3(120+110+115)​=115
• First Resistance (R1): $$R1=2\times 115-110=120$$
• Second Resistance (R2): $$R2=115+(120-110)=125$$

As the stock price moves the next day, traders will watch $120 and $125 as potential resistance levels. If the price approaches $120, they might consider selling or shorting the stock, anticipating resistance. If the price breaks through $120, they might look at $125 as the next resistance level.

Limitations

• Static Nature: Pivot points are static for the entire trading session and do not adapt to intraday price changes.
• False Signals: Like any technical indicator, pivot points can give false signals, especially in highly volatile markets.
• Historical Data Dependence: Pivot points are based on historical data and may not always predict future movements accurately.

Conclusion

Pivot point resistance is a valuable tool in technical analysis, providing traders with potential resistance levels based on historical price data. By understanding and effectively utilizing pivot points, traders can make more informed decisions about entry and exit points, manage risk better, and enhance their overall trading strategy. However, pivot points should be used in conjunction with other technical analysis tools and within the context of a comprehensive trading plan to maximize their effectiveness.